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Two out of Three Are Bad—And Slow Growth Now Diminishes Future Growth

November 8, 2012

WASHINGTON, DC—Peterson Institute experts forecast that for the next two years the United States will continue its weak economic recovery, while the euro area will stagnate on net. The ongoing sub-par growth in the United States and Europe is eroding economic potential and the prospects for debt reduction. Misguided fiscal policies, current and in prospect—including the possibility of going over the "fiscal cliff"—are far more harmful than widely recognized.

In contrast, Peterson Institute experts forecast a continued slowdown in China in 2013, but are optimistic this slowdown will be temporary and may be a prelude to needed rebalancing away from excessive savings and investment. Reforms under consideration by the new Chinese leadership could generate an ongoing growth rate of 8 percent.

According to David J. Stockton, the US economy is likely to continue its grindingly slow recovery, achieving 1.6 percent real GDP growth in 2012, 2.3 percent in 2013, and 2.8 percent in 2014. Stockton believes the United States will likely avoid going over the fiscal cliff, but warns that going over the cliff would be much worse for the economy than the Congressional Budget Office's analysis suggests.

Prolonging the period of poor macroeconomic outcomes will do long-term damage to the US economy—and to the labor market in particular.The adverse effects of slow growth onUS economic potential to date have been greater than official estimates.

Adam S. Posen forecasts that growth will be negative for years to come in the euro area periphery. He notes that the European Central Bank's conditional ease puts a floor under, and fiscal austerity commitments put a ceiling over, European growth prospects. As a result, the European situation will have less of an impact on the United States in the coming two years than it has had these past two years.

The 'structural reforms' underway in the euro area will not yield rapid benefits, Posen says. In the absence of a recovery in the region, such benefits will be outweighed by the structural damage done. The damage to workers and public finances from continued contraction similar in nature to those for the United States will be much worse in Europe. Simultaneous austerity will probably be self-defeating even in reducing public debt.

Nicholas R. Lardy notes China's growth has slowed for seven consecutive quarters, and may well slow further in the coming year. He projects China will slow to 7.7 percent real GDP growth in 2012. This, however, is not a sign of a long-term growth trap.

The weak global economy means China's external sector is now a slight drag on growth, but the moderation of residential housing investment is a more important factor slowing growth. China's new leaders can pursue reforms that would both bring down the investment share of GDP to a more sustainable level and generate an average growth rate of 8 percent over the next decade.

David J. Stockton, the Institute's newest Senior Fellow, was chief economist for the Federal Reserve Board from 2000–2011.

Adam S. Posen will become President of the Institute on January 1, 2013, and just completed a three-year term as a member of the Bank of England's Monetary Policy Committee.

Nicholas R. Lardy, the Institute's Anthony M. Solomon Senior Fellow, has been called "everybody's guru on China" by the National Journal. He is the author of Sustaining China's Economic Growth After the Global Financial Crisis(2012).

The Peterson Institute will hold a Global Outlook Panel with these and other Institute scholars semi-annually. The next such prospects session will be held in early April 2013.

About the Peterson Institute

The Peterson Institute for International Economics is a private, nonprofit, nonpartisan research institution devoted to the study of international economic policy. Since 1981 the Institute has provided timely and objective analysis of, and concrete solutions to, a wide range of international economic problems. Support is provided by a wide range of charitable foundations, private corporations and individual donors, and from earnings on the Institute's publications and capital fund.